While Progress Toward Earlier Intervention With Delinquent
Taxpayers Has Been Made, Action Is Needed to Prevent Noncompliance With
Estimated Tax Payment Requirements

February 2004

Reference Number:2004-30-040

This report has cleared the Treasury
Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted
from this document.

This
report presents the results of our review to determine whether the Internal Revenue Service (IRS) has effective
processes for achieving timely intervention when an underpayment or nonpayment
of income taxes, Federal Tax Deposits (FTD), and/or estimated taxes is
identified.Early intervention is
critical for the IRS, as the nation’s tax collection agency, because collection
theory holds that the earlier a debtor is contacted
for payment, the greater the likelihood that all or some of the debt will be
paid.Early intervention to
encourage and assist taxpayers to more promptly resolve their tax liabilities
was one of the goals of the former IRS Commissioner, as he tried to address the
amount of outstanding tax liabilities that had grown to $287 billion as of December
2002.

In
summary, over the course of
nearly the past decade, the IRS has taken a number of actions, and is planning
still others, to improve its ability to react more quickly to an actual or
potential tax debt.The completed
actions include shortening the collection notices cycle, implementing
predictive dialing technology for making outbound telephone calls on tax
delinquencies, and completing a major reorganization to align with the IRS’
major customer segments.Other actions
in progress include migrating toward a risk-based approach to collecting
delinquent taxes and modifying the FTD Alert criteria to focus on fewer,
better-targeted taxpayer contacts.

For two reasons,
however, it is difficult, if not impossible, to assess the cumulative effect
that these actions have had on the IRS’ Collection operations.The first reason is the decrease in
Collection function staffing.The
Full-Time Equivalents (FTE) allocated to Collection function operations
declined from 12,950 in Fiscal Year (FY) 1997 to 11,349 in FY 2002.Second, collection enforcement activities
were significantly affected by the enactment of the IRS Restructuring and
Reform Act of 1998 (RRA 98).Between FYs
1997 and 1999, for example, the number of liens filed declined from about
544,000 to about 168,000; the number of levies declined from almost 3.7 million
to about 500,000; and the number of seizures declined from about 10,000 to only
161.Although enforcement activity was
increasing by FY 2002, only the number of liens filed was approaching the
pre-RRA 98 levels.

Estimated tax is the method
used by individual taxpayers to pay taxes on nonwage income on a quarterly
basis.About 12 million taxpayers made
estimated tax payments totaling $183 billion for Tax Year (TY) 2001.However, there is significant taxpayer
noncompliance with estimated tax requirements.For each tax year from 1995 through 2000, between 5.7 million and 6.8 million
individual taxpayers were assessed penalties for making insufficient or late
estimated tax payments.Many of these
taxpayers also filed tax returns reporting unpaid taxes that resulted in the
IRS having to take costly collection actions.

Five factors contribute to
this noncompliance.First, the tax law
does not require tax withholding on nonwage sources of income.Second, the quarterly due dates prescribed
by law for making estimated tax payments do not consistently coincide with the
calendar quarters and are irregularly spaced from 61 to 122 days apart.Third, the estimated tax penalty rate, which
is currently only 4 percent, may not sufficiently deter payment noncompliance.Fourth, the IRS has no early intervention
programs to identify taxpayers that stop making estimated tax payments or that
make insufficient or untimely payments.Finally, the IRS has experienced little success (i.e., only about 1 in 200
taxpayers) in encouraging the use of electronic payment options for making
estimated tax payments.Without
proactive efforts by the IRS, the noncompliance with estimated taxes can be
expected to worsen in the years to come, since the amount of income from
nonwage sources of income is growing significantly faster than that from wages.

As a long-term solution to
the estimated tax payment noncompliance, we recommended the Commissioners of
the Large and Mid-Size Business (LMSB), Small Business/Self-Employed (SB/SE),
and Wage and Investment (W&I) Divisions explore developing a system of
mandatory withholding of income taxes from nonemployee compensation paid to
independent contractors by certain types of businesses for possible inclusion
in a legislative proposal to the Department of the Treasury.We also recommended legislative proposals to
require estimated tax payments to be made on a monthly basis and to change the
manner in which the estimated tax penalty rate is determined to ensure it
serves as a more effective deterrent to noncompliance with estimated tax
payment requirements.

For the near term, we
recommended the Directors, Compliance, SB/SE and W&I Divisions, and the
Director, Customer Assistance, Relationships, and Education, W&I Division,
develop an estimated tax payment reminder notice that can be sent at midyear to
those taxpayers that were assessed estimated tax penalties in the prior tax
year and had made no estimated tax payments for the first 6 months of the
current tax year or that had made substantially smaller or untimely payments
during the first 6 months.We also
recommended the Director, Taxpayer Education and
Communication, SB/SE Division, improve the promotion of electronic tax
payments by including the enrollment form for the Electronic Federal Tax
Payment System (EFTPS) in the estimated tax packages mailed to taxpayers,
expanding the brief explanation of the EFTPS in Tax Withholding and
Estimated Tax (Publication 505), and amending those IRS instructions and
publications applicable to estimated tax payments that do not sufficiently
emphasize that the EFTPS is offered to taxpayers as a free service by the
Department of the Treasury.

Management’s Response:The
Commissioner, SB/SE Division, provided a detailed response to our draft report,
advising that the Director, Field Specialists, LMSB Division, had agreed to
explore the feasibility of developing a system of mandatory withholding of
income taxes from nonemployee compensation paid to independent contractors in
large and mid-size businesses.The
Director, Field Specialists, will explore this action in coordination with
program managers in the SB/SE and W&I Divisions and the LMSB Division
Counsel.If developing a system of
mandatory withholding is feasible, the Director, Field Specialists, will draft
and coordinate a legislative proposal with the Office of Legislative Affairs
for consideration by the Department of the Treasury.

The Commissioner, SB/SE
Division, agreed with our recommendation to consider improving the promotion of
the electronic tax payments.An
E-Submissions Messaging Team is currently reviewing IRS products to ensure
EFTPS benefits are specifically detailed and highlighted as a “free” service
offered by the Department of the Treasury.This group will continue to review new ways to enhance Estimated Tax for
Individuals (Form 1040-ES) taxpayer compliance, including a proposal to add a
coded enrollment form for the EFTPS in the U.S. Individual Income Tax Return
(Form 1040) tax package to track the number of enrollments submitted through
the paper enrollment process.

The Commissioner, SB/SE
Division, disagreed with our recommendation to submit a legislative proposal
requiring monthly estimated tax payments on the 15th day of each
month.The Commissioner stated that,
although there may be some benefit to establishing regular quarterly time
periods for individual estimated tax payments, monthly estimated tax payments
would increase burden and complexity for both compliant and noncompliant
taxpayers.The Commissioner added that
increasing the number of payments would increase both the complexity of
Underpayment of Estimated Tax by Individuals, Estates, and Trusts (Form 2210)
and the difficulty of computing estimated tax penalties for noncompliant
taxpayers.

The Commissioner, SB/SE
Division, disagreed with our recommendation to submit a legislative proposal to
change the manner in which the estimated tax penalty rate is determined,
stating the IRS had developed a legislative proposal concerning the estimated
tax penalty in July 2001.The proposal
recommended the Congress raise the minimum underpayment amount on which
penalties are assessed for failure to make estimated tax payments.It also proposed to change the rate at which
the estimated penalty is determined.The
proposed changes would apply to tax years beginning after December 31, 2003.

The Commissioner, SB/SE
Division, disagreed with our recommendation to develop an estimated tax
reminder notice that can be sent at midyear to those taxpayers that were
assessed estimated tax penalties in the prior tax year and were falling behind
with estimated tax payment requirements.The Commissioner stated the IRS had initiated a project in 2000 to
determine whether a “soft letter” would significantly increase FTD payment
compliance.Based on the results of
that study, the Commissioner believes a reminder notice would have little or no
impact on estimated tax payment compliance.

Finally, the Commissioner,
SB/SE Division, disagreed with our estimate that penalty and interest could be
reduced by $2.1 billion over 5 years if a 25 percent increase in payment
compliance was achieved, stating this percentage was not based on any empirical
data.The Commissioner also disagreed
with our estimate that sending reminder notices to taxpayers assessed estimated
tax penalties could reduce collection costs by $12.9 million over 5 years,
stating that, based on the results of the FTD “soft letter” study, there would
be no collection cost savings.The
Commissioner added that our estimate did not reflect the administrative cost related
to adding a midyear reminder notice.Management’s complete response to the draft report is included as
Appendix V.

Office of Audit Comment:Given the
significant increase in nonwage income and the extensive noncompliance with
making estimated tax payments, we continue to believe taxpayers could benefit
from a system of regularly scheduled monthly payment dates.The fact that nearly one-third of the
taxpayers that make estimated tax payments incur penalties strongly suggests
the current quarterly payment system, in place since 1943, is not working
effectively.Monthly payment intervals
are an established and common business practice in the private sector.Most Americans are already used to making
monthly payments on their home mortgages, rent, car loans, credit cards, and
utilities.In addition, many homeowners
have mortgage escrow accounts set up to have money held to pay property taxes
and insurance premiums so they do not have to worry about coming up with
several large lump sum payments, each with different due dates, throughout the
year.Also, taxpayers that cannot pay
the full amount with their individual income tax returns can make arrangements
with the IRS to make monthly installment payments.We believe the Commissioner’s concern with the taxpayer burden
associated with a monthly payment system would be alleviated with the
successful promotion of electronic payments.In addition, the IRS instructions for Form 2210 state that taxpayers do
not need to file Form 2210 in most cases if an estimated tax penalty is due and
that, because the Form is complicated, the IRS strongly encourages the taxpayer
to let the IRS figure the penalty.Finally, substantial taxpayer burden would be reduced if the monthly
payment system helped taxpayers avoid estimated tax penalties.

We also believe our
recommendation to change the manner in which the estimated tax penalty rate is
determined has merit to ensure the penalty serves as a more effective deterrent
to noncompliance with estimated tax payment requirements.The legislative proposal cited by the
Commissioner, SB/SE Division, would raise the minimum underpayment amount on
which penalties are assessed for failure to make estimated tax payments and
would apply the underpayment rate on a daily basis.While applying the underpayment rate on a daily basis would
slightly increase the amount of the penalty, the increase would not be
sufficient to serve as an effective deterrent to avoiding estimated tax
payments.

We believe the concept of a midyear reminder
notice to taxpayers that have stopped making estimated tax payments should, at
a minimum, be tested.The Commissioner,
SB/SE Division, cited the results of an FTD “soft letter” project as evidence
that a reminder notice would have little or no impact on estimated tax payment
compliance.However, the IRS’ own final
report, dated March 2003, on the results of that project recommended “further
study about the effectiveness of the ‘soft letter’ as an early intervention
tool to improve filing and payment compliance may be warranted.”Further, the FTD “soft letter” was directed
to businesses responsible for paying employment taxes.This customer segment differs from
individual taxpayers that are responsible for making estimated tax payments on
their nonwage income.

While the Commissioner,
SB/SE Division, is correct that there are no empirical data to support our
assumption that a midyear reminder notice would improve payment compliance by
25 percent, our estimate that penalties and interest could be reduced by $412.7
million per year, or $2.1 billion over 5 years, was based on 285,400 taxpayers
becoming payment compliant.These
285,400 taxpayers represented only about 5 percent of the 5.7 million
noncompliant taxpayers that incurred estimated tax penalties in TY 1998.Similarly, our estimate of the cost savings
that could be realized through a 25 percent improvement in payment compliance
was based on avoiding collection action on 204,000 taxpayers.Our estimate of the collection cost savings
was reduced by the estimated cost to mail the reminder notices.

While we still believe all
of our recommendations are worthwhile, we do not intend to elevate our
disagreement concerning these matters to the Department of the Treasury for
resolution.

Copies of this report are also
being sent to the IRS managers affected by the report recommendations.Please contact me at (202) 622-6510 if you
have questions or Richard J. Dagliolo,
Acting Assistant Inspector General for Audit (Small Business and Corporate
Programs), at (631) 654-6028.

The Internal Revenue Service (IRS) is the nation’s tax
collection agency.Its mission is to
provide America’s taxpayers with top-quality service by helping them understand
and meet their tax responsibilities and by applying the tax law with integrity
and fairness to all.

Collecting taxes due the Federal Governmenthas
always been a challenge for the IRS, but in recent years the challenge has
grown.In various testimonies and audit
reports, the General Accounting Office (GAO) and Treasury Inspector General for
Tax Administration (TIGTA) have highlighted large and pervasive declines in the
IRS Compliance and Collection programs.Between Fiscal Years (FY) 1996 and 2001, these programs generally
experienced larger workloads, less staffing, and fewer numbers of cases closed
per employee.By the end of FY 2001,
the IRS was deferring collection action on about one out of every three tax
delinquency cases assigned to the Collection program.

As of
December 2002, the total amount of outstanding tax liabilities was $287
billion.Approximately $13 billion of
this total has been designated as uncollectible due to the IRS’ collection and
resource priorities, although many of these accounts could be collected if the
taxpayers were contacted and offered the opportunity to pay either in full or
in installments.

Collection theory holds that the earlier
a debtor is contacted for payment, the greater the likelihood that all or some
of the debt will be paid.Early
intervention to encourage and assist taxpayers to more promptly resolve their
tax liabilities was one of the goals of the former IRS Commissioner.

To perform this audit, we interviewed management officials
in the Small Business/Self-Employed (SB/SE) Division offices in New Carrollton,
Maryland, and Oxon Hill, Maryland; analyzed taxpayer account information;
reviewed various IRS reports and studies; and sent questionnaires to nine state governments concerning their tax
collection techniques and early intervention practices.The responses received did not reveal any
unique practices or techniques that would benefit the IRS operations.

The audit was performed from November 2002 through March
2003 and in accordance with Government
Auditing Standards.Some of the data used in this report came
from various IRS reports.We did not
verify the accuracy of the information from those sources.Detailed information on our audit
objective, scope, and methodology is presented in Appendix I.Major contributors to the report are listed
in Appendix II.

Historically, delinquent accounts have generally followed
the same treatment path at the IRS.The
collection process generally began with a series of notices that were sent to
taxpayers that did not pay all of their tax liabilities when they filed their
tax returns.If the unpaid taxes were
not resolved during the notice process, the case was sent to the Automated
Collection System (ACS) function where Customer Service Representatives (CSR)
initiated and responded to telephone and/or correspondence contacts with the
taxpayers and third parties, filed liens, and/or took levy actions to resolve
the delinquencies.If the ACS function
was unable to resolve the delinquencies, the cases were moved to the Collection
Field function (CFf) where, when resources became available, they were assigned
to revenue officers for face-to-face contact with the taxpayers.

Over the course of nearly the past
decade, the IRS has taken a number of actions, and is planning still others, to
improve its ability to respond more quickly to an actual or potential tax
debt.For two reasons, however, it is
difficult, if not impossible, to assess the cumulative effect these actions
have had on the effectiveness of the IRS Collection operations.

The first reason is the decrease in Collection function
staffing.For example, the Full-Time
Equivalents (FTE) allocated to the Collection function declined from 12,950 in
FY 1997 to 11,349 in FY 2002.Second,
collection enforcement activities were significantly affected by the enactment
of the IRS Restructuring and Reform Act of 1998 (RRA 98).Between FYs 1997 and 1999, for example, the
number of liens filed declined from about 544,000 to about 168,000; the number
of levies declined from almost 3.7 million to about 500,000; and the number of
seizures declined from about 10,000 to only 161.Although enforcement activity was increasing by FY 2002, only the
number of liens filed was approaching the pre-RRA 98 levels.

A formal Early Intervention Program was implemented

In January 1995, the IRS
implemented in the ACS function a formal Early Intervention Program that used
both a shortened notice process and earlier taxpayer contact.In the Early Intervention Program, the
collection process was shortened by eliminating two notices for taxpayers
filing individual income tax returns and by eliminating one notice for
taxpayers filing business returns.At
each ACS call site, special teams of CSRs were designated to work the Early
Intervention Program inventory.For
cases with telephone numbers, the procedures for the Early Intervention Program
required that up to four outbound calls be made by the second week.

Later in Calendar Year (CY) 1995,
the ACS function resources were reduced and applied to other priority work and,
as a result, a formal Early Intervention Program no longer exists.However, the IRS has maintained the
same shorter notice process that the Early Intervention Program used, and
outbound call attempts are still being made on most new cases that have an
available telephone number.

Predictive dialing technology was deployed for making
outbound telephone calls

The IRS began testing a predictive dialer at its ACS call
site in Buffalo, New York, in CY 1996.The IRS’ evaluation showed the predictive dialer increased outgoing call
productivity and decreased the inventory in the ACS Contact function.In June 1999, the Buffalo site began
supporting the outbound call “campaigns” from other ACS call sites.This consolidation was completed in January
2000, and in February 2002, a weekly rotational schedule was implemented that
provided for outbound calls to be made for each of the ACS call sites.

The IRS still uses its original predictive dialer system for
making outbound calls on new cases coming into the ACS function and for making
outbound calls as a last attempt to contact taxpayers prior to issuing a Notice
of Levy.A vendor provides telephone
number research for cases coming into the ACS function.A recent analysis showed approximately 57
percent of these incoming cases have a telephone number.During FY 2002, the ACS function used the
predictive dialer to make 1.3 million
outbound call attempts on 1.2 million taxpayer accounts.

The current
IRS predictive dialer system is outdated, is no longer supported by the vendor,
and is beginning to experience frequent downtime.In a separate audit report, we recommended
the IRS (1) pursue additional human capital or reallocate Compliance resources
to enable the operation of present and future predictive dialer systems at full
capacity, and (2) pursue a budget
solution that would allow the IRS to replace the current predictive dialer
system with a state-of-the-art system with sufficient capacity.

The IRS completed a major reorganization based on customer
segments

The RRA 98 mandated that the IRS do a
better job of meeting the needs of its customers.To comply with this Congressional mandate, the IRS revised its
mission statement to refocus its emphasis on helping taxpayers understand and
meet their tax responsibilities.On October
2, 2000, the IRS also modernized its organizational structure from one that was
based on function and geography to one that is aligned with its major customer
segments.Four new customer-focused
business operating divisions were created with full end-to-end responsibility
for serving distinct groups of taxpayers with similar needs.

The new organizational structure is designed to provide
more-focused customer service and enhance accessibility to IRS information and
personnel that can resolve issues more quickly and consistently within that
operating division.The new structure
was built around specific taxpayer needs that will enable the IRS to tailor its
products, services, and compliance approaches to business practices and
strategies.In this way, the IRS can
develop a comprehensive and focused approach to tax administration, allocate
the necessary resources, and shift to problem prevention and early intervention
initiatives.

In October 2001, the SB/SE Division implemented changes to
the inventory delivery system to alter the mix of cases assigned to revenue
officers.The changes delivered younger,
predominately in-business trust fund cases to revenue officers to be worked as
the highest priority.The expected
benefits of this plan were:

·Higher collectibility than other cases.

·High compliance impact with opportunities to stop the
noncompliance since the taxpayers are still in business.

Significant
potential for revenue protection by preventing pyramiding through early
intervention.

Through
the reorganization, the IRS expects to achieve, over time, improved compliance
through faster intervention in collection and through a more effective
risk-based approach in all Compliance activities.This approach will allow the IRS to more clearly differentiate
between those taxpayers that are attempting to comply but need assistance and
those that potentially require enforcement action (a smaller segment).

The IRS is migrating toward a risk-based approach to
collecting delinquent taxes and contracting out the collection of some
delinquent taxes

Under this approach, taxpayer
characteristics are analyzed to determine the most appropriate treatment rather
than having all delinquent accounts follow the same treatment path.While some cases may follow the normal
treatment path, others may be accelerated to the ACS function or the CFf.

For example, a
Filing and Payment Compliance (F&PC) Model in the Business Systems
Modernization effort has a goal to shorten the payment compliance life cycle to
6 months.All balance due cases will
receive the statutory first notice.However, cases will not receive a “one size fits all” compliance
approach but rather a tailored treatment, as the taxpayer may receive one
notice or a series of notices.Outbound
calls will also be emphasized.

Although a pilot was planned for April 2004, the Office of
Management and Budget has not approved further funding due to budgetary
constraints.At the time we completed
our review, the project remained on hold.

Another initiative is a
legislative proposal to contract with private agencies to assist in the IRS’
collection of delinquent taxes.This
proposal, which requires the approval of the Congress, would expand the IRS’
capacity to collect delinquent taxes by authorizing private tax collection
agencies to pursue lower-priority, less-complex, unresolved tax delinquency
cases that accumulate in inventory and might not otherwise be addressed because
of limited resources.At the time we
completed our review, the Congress had not acted on this proposal.

The FTD Alert criteria are being modified

The Federal Tax Deposit (FTD) Alert
Program is an existing early intervention process which identifies taxpayers
that appear to be behind in their deposits of trust fund taxes before their
quarterly employment tax returns are due to be filed.The FTD Alerts are computer generated on a quarterly basis for
those businesses that appear to be making insufficient FTD payments when
compared to those made in prior quarters.The FTD Alerts are assigned to revenue officers in the CFf for contact
with the business taxpayers.

FTD Alerts can protect the Federal Government’s
interest by the early identification of potential delinquent employment tax
accounts.They also serve the
taxpayers’ interests by allowing IRS involvement before enforced collection
action or bankruptcy become the two remaining alternatives.

During CY 2002,
135,187 FTD Alerts were created.Of
these, 45,675 were mandatory alerts and 89,512 were optional alerts.Due to resource limitations and workload
priorities, the CFf did not work all of the mandatory alerts and did not work
any of the optional alerts.

At the time we performed this review, the IRS was in the process of significantly changing the FTD
Alert Program to address recommendations from internal research studies and
audit reports issued by the former IRS Inspection function and the TIGTA.The IRS expected
to complete the testing of the new FTD Alert criteria by January 2004.

The IRS has delayed taking action on one previous audit
recommendation to look at alternate functions, such as the ACS function, for
working FTD Alerts.The IRS was
evaluating the feasibility of issuing a “soft letter” to taxpayers on some FTD
Alert cases and expected a decision by August 2003.

Approximately 12 million taxpayers made estimated tax
payments totaling $183 billion for Tax Year (TY) 2001.The tax law generally requires taxpayers to
make estimated tax payments if (1) they expect to owe at least $1,000 in tax,
after subtracting their withholding and credits, and (2) they expect their
withholding and credits to be less than the smaller of 90 percent of the
current year tax liability or 100 percent of the prior year tax liability.The
estimated tax system supports the “pay as you go” concept of paying taxes on
nonwage sources of income.For
estimated tax purposes, the year is divided into four payment periods with
specific payment due dates.

The IRS may assess an estimated tax penalty if a taxpayer
did not pay enough taxes through withholding or estimated tax payments.An estimated penalty may also be assessed if
a taxpayer does not pay enough tax by the due date of each of the four
quarterly payment periods.

There is significant noncompliance with estimated tax
payment requirements

Understanding
estimated tax payments is one of the most serious problems encountered by
taxpayers, according to the National Taxpayer Advocate FY 2001 Annual Report to
Congress.The estimated tax penalty is
the second most frequently assessed penalty against individual taxpayers.

An IRS study showed
31 percent of the taxpayers that either made, or were required to make,
estimated tax payments for TY 1999 were assessed the estimated tax
penalty.In contrast, only about 3.2
percent of individual taxpayers that had not made estimated tax payments were
penalized for the late filing of returns or the late payment of taxes in TY
1998.

Figure 1 shows
that, for each tax year from 1995 through 2000, the IRS penalized between 5.7
million and 6.8 million taxpayers for making late or insufficient estimated tax
payments.For these 6 years, the net
estimated tax penalties totaled almost $7.5 billion and averaged more than $1.2
billion per year.

Figure 1:Number of Estimated
Tax Penalties:TYs 1995 - 2000

Figure 1 was removed due to its size.To see Figure 1, please go to the Adobe PDF version of the report on the
TIGTA Public Web Page.

Noncompliance
with estimated taxes is costly for the Federal Government

Not only is noncompliance with estimated tax payment
requirements costly for those taxpayers assessed penalties, it also delays the
flow of tax revenues to the Federal Government and often requires the IRS to
take costly collection actions.For
example, we analyzed the accounts of more than 2 million of the 5.7 million
individual taxpayers that were assessed estimated tax penalties for TY
1998.Approximately 58 percent of these
taxpayers had made no estimated tax payments.These 2 million taxpayers had tax liabilities totaling $5.9 billion that
were not fully paid when their tax returns were filed, resulting in the issuance
of 2.7 million collection notices for more than 1.5 million taxpayers.About 331,000 of these accounts ultimately
reached Taxpayer Delinquent Account (TDA) status that often requires the IRS to
take stronger, more labor-intensive actions to collect the debts.

We estimate the IRS incurred more than $18 million in
collection costs for these 1.5 million noncompliant taxpayers.Approximately 1 million of these taxpayers
were self-employed.

Several
factors contribute to taxpayer noncompliance in making estimated tax payments

Several factors contribute to the significant noncompliance
with estimated tax requirements:

·At the root of the issue is that the tax law does not
require payers to withhold taxes from nonwage payments.Nonwage sources of income continue to grow
as a proportion of total income.

The
potential risk for skipped or late estimated tax payments is also
increased because the quarterly due dates prescribed by law for making the
payments do not consistently coincide with the calendar quarters.

The
estimated tax penalty is based on the Federal Government short-term
interest rate, which is at its lowest level in 45 years, and may not
provide a sufficient deterrent to noncompliance with estimated tax payment
requirements.

·While the IRS is working on
improving its alert system for employment tax deposits, there are no parallel
early intervention programs to identify individual taxpayers that stop making
quarterly estimated tax payments or that may be making insufficient or untimely
payments.

The
IRS has experienced little success in encouraging taxpayers to use
electronic payment options for making estimated tax payments.

Nonwage income is not subject to mandatory tax withholding

The law requires employers to
withhold income taxes and Social Security/Medicare contributions from their employees’
wages and send the withheld taxes to the IRS.Withholding is a fundamental premise of the voluntary compliance system
for individual taxpayers in that it provides for a gradual and systematic
method to pay taxes.

In 1999, the GAO reported the tax compliance rate for wage
earners was 99 percent.However, the compliance rate is much lower
for taxpayers with nonwage sources of income, such as self-employment, capital
gains, interest, and dividends, for which taxes are generally not withheld.

When there is no
withholding, taxpayers are required to make quarterly estimated tax
payments.Self-employed taxpayers must
make sufficient estimated tax payments to cover both their income taxes and
Social Security/Medicare taxes, which since TY 1990 have been 15.3 percent of
the net self-employment income.

IRS Statistics of Income (SOI) data for individual income
tax returns filed during 1997 showed 2.3 million (26 percent) of the 8.8
million unpaid balance due returns involved taxpayers that had no withholding.An IRS analysis of the 122 million
individual income tax returns filed in CY 1998 found that over 30.5 million (25
percent) involved insufficient tax prepayments and reported a balance due with
filing.In 1999, the GAO reported the
compliance rate for self-employed individuals was 80 percent.As of December 31, 2000, self-employed
taxpayers owed the IRS approximately $25 billion in delinquent taxes, interest,
and penalties.

Nonwage income continues to increase as a percentage of total income

In 1996, the GAO reported nonwage income had been a
growing proportion of individual taxpayers’ total incomes from 1970 through the
1980s, peaking in 1989.As shown in
Figure 2, the percentage of nonwage income to total income leveled off between
1990 and 1995 but had significantly increased by 2000, the last year for which
information was available.

Figure 2:Growth in Nonwage Income from 1975 to 2000

Figure 2 was removed due to its
size.To see Figure 2, please go to the
Adobe PDF version of the report on the TIGTA Public Web Page.

Between 1975 and 2000, nonwage income grew significantly,
from 17.4 percent of total income ($167 billion) to 30.6 percent of total
income (nearly $2 trillion).This
represents a 76 percent increase in the proportion of nonwage income to total
income and an approximately 12-fold growth in total nonwage income.

As shown in Figure 3, the growth of
nonwage income can also be illustrated by the increase in the percentage of
individual income tax returns filed that report only nonwage
income.Overall, the returns reporting
only nonwage income increased from 10.6 percent (8.7 million of 82 million
income tax returns filed in 1975) to 14.8 percent (19.2 million of 129 million
income tax returns filed in 2000).

Figure
3:Growth of Tax Returns With Only
Nonwage Income

Figure 3 was removed due
to its size.To see Figure 3, please go
to the Adobe PDF version of the report on the TIGTA Public Web Page.

Figure 4 compares the growth in the
largest nonwage sources of income to the growth in income from wages for the
25-year period from 1975 to 2000.Except for interest, each nonwage source had increased from about three
to eight times more than wages.

Figure 4:Growth in Tax Returns With Wages and Nonwage Income

Figure 4 was removed
due to its size.To see Figure 4, please
go to the Adobe PDF version of the report on the TIGTA Public Web Page.

Past efforts to mandate withholding on nonwage sources of income have
failed

As early as 1979, the GAO
concluded noncompliance among independent contractors was serious enough to
warrant some form of tax withholding on the payments made to them.During the 1990s, at least two GAO reports
and Congressional testimonies suggested withholding taxes from payments to
independent contractors.To support
this position, the GAO cited various IRS studies and data that showed a
significantly lower level of compliance among independent contractors as
compared to employees.

A 1992 report by the Joint Committee on Taxation also acknowledged the revenue
loss associated with the lower compliance rates of independent contractors and made suggestions to
improve compliance and enforcement.One
suggestion was to require businesses to withhold income and employment taxes
from payments to independent contractors.

In 2001, we reported that, for TYs 1995 through 1998, the
IRS had received about 9.6 million Statements for Recipients of Miscellaneous
Income (Form 1099-MISC), reporting approximately $204 billion in nonemployee
compensation to independent contractors, that either did not contain a Taxpayer
Identification Number (TIN) for the payee or match the IRS records of assigned
TINs.Consequently, the IRS could not
use these information documents in its computer-matching programs to determine
whether the recipients of this compensation filed tax returns and/or reported
all of the income.

Our report recommended the
IRS propose changes to the tax law to require the mandatory withholding of
income taxes on nonemployee compensation payments.However, the IRS took no action on this recommendation.The IRS responded it had previously
submitted proposals for legislative changes to the Department of the Treasury
that would require mandatory withholding of income taxes on nonemployee
compensation payments and, in the past, the Department of the Treasury had
chosen not to forward these proposals to the Congress.

The due dates for making estimated tax payments do not
consistently coincide with the calendar quarters

The Current Tax Payment Act of 1943
established the statutory requirements for making estimated tax payments.At the time this law was enacted, the due
date for filing individual income tax returns was March 15.The Congress originally established the
estimated tax payment due dates as the 15th day of the third month
of each quarter (i.e., March 15, June 15, September 15, and December 15).

The Congress amended
the law the following year to change the due date for the fourth estimated tax
payment to January 15, to provide taxpayers the opportunity to file their
returns with payment in lieu of making a fourth quarterly estimated tax
payment.In 1954, the Congress amended
the tax code to change the due date for filing an individual income tax return
and for making the first estimated tax payment from March 15 to April 15.However, the Congress did not revise the due
dates for the other quarterly estimated tax payments to coincide with this
change.

Thus, for nearly 50 years, taxpayers
have been required to comply with the confusing estimated tax payment schedule
shown in Table 1.

Table 1:Estimated Tax Payment Schedule

Payment
Due Date

For Income
Received

Calendar Days Since Last Payment Due Date

April 15

January 1 through
March 31

90

June 15

April 1 through
May 31

61

September 15

June 1 through August 31

92

January 15

September 1 through
December 31

122

Source:Tax Withholding and Estimated Tax
(Publication 505).

The risk for skipped or late estimated tax payments is
increased because the quarterly due dates prescribed by law for making the payments
do not consistently coincide with the calendar quarters.As a result, two estimated payments are
required to be made during the second quarter (i.e., April - June) of each year
while none are required to be made during the fourth quarter (i.e., October -
December).In addition, the number of
calendar days between the estimated tax payment due dates ranges from 61 to
122.

In 2002, the IRS conducted a series of focus groups with
practitioners to gather suggestions for improving communication with taxpayers
and practitioners and for reducing the burden on small business taxpayers.When asked about the most burdensome tax
issues facing the small business taxpayer, several participants stated:

The timing of the estimated
payments does not make sense.The due
dates create problems for a business working on a quarterly basis.It is difficult to estimate taxes before a
quarter has ended.For example,
estimating the appropriate payment on June 15, when earnings will continue
until June 30, presents a dilemma for the taxpayer.

The estimated tax penalty is not providing a sufficient
deterrent to payment noncompliance

The estimated tax penalty is computed by applying an
underpayment rate to the amount of the underpayment for the period of the
underpayment.The estimated tax penalty
amount is equivalent to the dollar amount of interest on the unpaid amount for
the period of the underpayment.The
Internal Revenue Code (I.R.C.) specifies that the underpayment rate is the sum
of the Federal Government short-term interest rate plus three percentage
points.The rate of interest is
determined on a quarterly basis.

For TY 1999, when
an IRS study showed 31 percent of the taxpayers that either made, or were
required to make, estimated tax payments were assessed estimated tax penalties,
the penalty rate was 8 percent.The
study also showed 60 percent of the taxpayers that were assessed estimated tax
penalties for TY 1999 were charged less than $100.

The estimated tax penalty rate, which has subsequently
dropped to very low levels, may not provide a sufficient deterrent for not
making timely, appropriate estimated tax payments.As of October 1, 2003, the Federal Government short-term interest
rate was only 1 percent, its lowest level in 45 years.Therefore, the penalty for missing an
estimated tax payment for the October 1 through December 31, 2003, quarter
would have been 4 percent of the underpaid amount for the 3-month period.

There are no early intervention programs to identify
taxpayers that are not making estimated tax payments

The significant noncompliance in making quarterly estimated
tax payments on nonwage income, evidenced by the millions of estimated tax penalties assessed by the IRS
each year and the amount of unpaid taxes that requires costly collection action
by the IRS, demonstrates that the current system is not adequately
serving taxpayers or the IRS.We believe these taxpayer and Federal
Government costs could be significantly reduced if the IRS used its available
taxpayer account information to more timely assist taxpayers in properly making
their estimated tax payments.

The IRS runs computer programs at different times of the
year to identify the approximately 20.8 million taxpayers that are sent
estimated tax payment vouchers by mail.

In
January of each year, the IRS conducts an annual mail-out of estimated tax
packages to about 16 million taxpayers that, for the previous tax year,
made estimated tax payments and/or were assessed estimated tax
penalties.The packages include 4
payment vouchers the taxpayers should use for the 4 payment periods during
the next 12 months.

In
March, the IRS performs a similar mail-out of estimated tax packages to
about 300,000 taxpayers that may have filed their tax returns late and,
thus, were not identified for the earlier annual mail-out.

In
June, the IRS mails estimated tax packages to about 1.5 million taxpayers
that did not make estimated tax payments for the last tax year but
submitted a generic, over-the-counter, estimated tax payment voucher
during the first payment period for the current tax year.This mail-out includes the payment
vouchers the taxpayers should use for the following three payment periods.

In
September, the IRS mails estimated tax packages to about 3 million
taxpayers that did not make estimated tax payments for the last tax year
but submitted a generic, over-the-counter, estimated tax payment voucher
during the second payment period for the current tax year.This mail-out includes payment vouchers
the taxpayers should use for the following two payment periods.

While the IRS makes significant efforts to ensure estimated
tax payment vouchers are provided to those taxpayers that need them, it takes
no action to monitor payment compliance until the taxpayers file their returns
12 to 15 months later.If the taxpayers
misplace the annual estimated tax package with the four payment vouchers,
forget to make the estimated tax payments throughout the year, do not know in advance the amount of their
final tax liability, or do not know how much they paid in estimated taxes the
previous year, they will likely be penalized for skipped, late, or insufficient
estimated tax payments.

In 1999, the GAO recommended the IRS test the feasibility of
sending reminder notices to self-employed taxpayers that were assessed an
estimated tax penalty in the prior year and had made no estimated tax payments
in the current year.The IRS initially
requested computer programming to develop the reminder notices for 2000, but, due
to limited resources, management decided to delay implementation until 2001.The IRS subsequently closed this
recommendation without any action based on information from a June 2000
initiative that tested the effect of a prefiling notice on repeat high-income
nonfilers.Currently, there are no
reminder notices sent for estimated taxes.

Sending reminder notices shortly before the estimated tax
payments are due was also suggested to the IRS during a July 2001 study to
determine taxpayer attitudes toward paying estimated tax payments through electronic
methods.Focus group participants were
asked about anything additional the IRS could do to encourage use of automatic
funds withdrawal or credit cards to pay estimated taxes.One of their suggestions stated:

The participants in our focus
groups like to be notified of upcoming liability payments of any kind.Therefore, complete a cost benefit analysis
to determine the most effective way to send taxpayers a reminder notice about
their upcoming quarterly estimated tax payments.Reminder notices could be accomplished through direct mailings,
newspapers, public service announcements, advertisements in retirement
magazines and reminders in bank or stockbroker statements to name a few.

At the time we completed our review, the IRS had taken no
action toward adopting this suggestion.

We believe the IRS should reconsider the reminder notice
concept as a strategy for improving estimated tax payment compliance and
reducing its collection costs.Based on
our computer analysis of the TY 1998
accounts of 2,025,189 taxpayers that had been assessed estimated tax penalties,
we believe 1,141,599 (56 percent) of these taxpayers could have benefited from
midyear reminder notices from the IRS as a potential means to prevent or
minimize future estimated tax penalties, future balance due returns, and future
accounts receivables.These 1,141,599
taxpayers owed $3.8 billion in taxes after filing their TY 1998 returns and had
been assessed estimated tax penalties totaling $412 million, other penalties
totaling$756 million, and interest
totaling $732 million.These 1,141,599
taxpayers included:

·603,533 taxpayers that were assessed estimated tax penalties for TY 1997 but made
no estimated tax payments for TY 1998.

·111,913 taxpayers that made estimated tax payments for
TY 1997 but made none for TY 1998.

154,731
taxpayers that made substantially
smaller estimated tax payments for TY 1998 than for TY 1997.

The IRS’ cost for the current annual mail-out of estimated
tax packages each January is approximately $5 million.We estimate the additional IRS costs to mail
estimated tax payment reminder notices to the 1,141,599 taxpayers in our sample
that could have benefited from a reminder notice would have been $194,000.Assuming that 25 percent of these taxpayers
became payment compliant as a result of the reminder notice, these taxpayers
could avoid approximately $413 million in penalties and interest and the IRS
could reduce its collection costs by $2.6 million.See Appendix IV for details.

Compliance could be improved by encouraging more taxpayers
to make estimated tax payments electronically

The IRS encourages
taxpayers to pay their taxes through electronic funds withdrawals and credit
cards as alternatives to writing checks and mailing payment vouchers.However, IRS data show the overwhelming
majority of the estimated tax payments the IRS receives are in the form of
traditional paper payment vouchers and taxpayer checks.For example, a profile of taxpayers that
made estimated tax payments for TY 1999 showed less than one-half of 1 percent
(i.e., 1 in 200) of the 13 million taxpayers had used electronic methods for
making their payments.A second profile
for TY 2001 showed 38,766,000 (99.9 percent) of the 38,819,000 estimated tax
payments received were made via paper.

The IRS has studied
how to increase taxpayer usage of electronic estimated tax payments.For example, a focus group study was
performed in July 2001 to determine taxpayer attitudes toward paying estimated
taxes through electronic methods.The
general consensus across the group of participants was that they would not use
credit cards to make their estimated tax payments as long as the credit card
companies continued to charge a convenience fee.

For the past
several years, the IRS has also provided taxpayers with an Electronic Federal
Tax Payment System (EFTPS) for making tax payments electronically using the
Internet, computer software, or telephone.The EFTPS is offered free by the Department of the Treasury to both
business and individual taxpayers.

Taxpayers must
enroll in the EFTPS.Estimated tax
filers may call a toll-free number to request an Individual Enrollment
Form for EFTPS (Tax Form 9783) or
enroll through the Internet.Within 15
business days, the taxpayer is mailed a Personal Identification Number and
confirmation materials that include instructions on obtaining a password for
secure use of the EFTPS Internet site.At least 1 calendar day prior to the estimated tax payment due date, the
taxpayer can access the EFTPS by telephone or on-line.The system will prompt the taxpayer for the
necessary information to complete the payment.The system processes the information and, once the tax payment is accepted,
a withdrawal is initiated from the taxpayer’s bank account, the funds are
transferred to the Treasury account, and the payment information is reported to
the IRS to update the taxpayer’s account.

Until recently, however, taxpayers could use the EFTPS to
schedule only one estimated tax payment at a time.In July 2003, the IRS enhanced the EFTPS so taxpayers can
schedule all four quarterly estimated tax payments at the same time.

Information about the EFTPS is contained in the general tax
package instructions and several other IRS publications.However, the fact that the EFTPS is offered
as a “free” service by the Department of the Treasury is not covered in several
key IRS publications such as the Estimated Tax for Individuals (Form 1040-ES
and Form 1040-ES/V (OCR)) instructions and Tax Withholding and Estimated Tax
(Publication 505).The EFTPS is only
briefly described in these documents.For example, in Publication 505 (Rev. December 2002), the reference to
the EFTPS is limited to two sentences on page 24.

To address the significant noncompliance in paying estimated
taxes, the Commissioners, Large and Mid-Size Business (LMSB), SB/SE, and
W&I Divisions, should work with the IRS Office of Legislative Affairs
to:

1.Explore the development of a system of mandatory withholding
of income taxes from nonemployee compensation paid to independent contractors
for possible inclusion in a legislative proposal, similar to the one we
previously recommended in 2001, for submission to the Department of the
Treasury.To avoid placing undue burden
on small businesses, the IRS should limit the requirement to withhold taxes on
nonemployee compensation to large and mid-size businesses.

Management’s Response:The Director, Field Specialists, LMSB Division, agreed to explore
the feasibility of developing a system of mandatory withholding of income taxes
from nonemployee compensation paid to independent contractors in large and
mid-size businesses.The Director, Field
Specialists, will explore this action in coordination with program managers in
the SB/SE and W&I Divisions and the LMSB Division Counsel.If developing and implementing a system of
mandatory withholding for these taxpayers is feasible, the Director, Field
Specialists, will draft and coordinate a legislative proposal with the Office
of Legislative Affairs for consideration by the Department of the Treasury.

To minimize taxpayer confusion with the estimated tax
payment due dates and increase the effectiveness of the estimated tax penalty
as a deterrent to payment noncompliance, the Commissioners, SB/SE and W&I
Divisions, should work with the IRS Office of Legislative Affairs to:

2.Develop a legislative proposal, for submission to the
Department of the Treasury, to change the estimated tax payment due dates from
the current irregular schedule, which requires 4 payments that are spaced from
61 to 122 days apart, to a regular monthly schedule with payments due on the 15th
day of each month and with the last payment due January 15.We believe this change would promote payment
compliance by evenly spacing the due dates approximately 90 days apart,
requiring smaller individual payments by the taxpayer, and encourage use of the
EFTPS for making electronic payments.The increased frequency of estimated payments would also expedite the
flow of revenue into the Treasury in comparison to the existing system.Taxpayers would also benefit because the
estimated tax penalty for a skipped or late monthly payment would be less than
that for a skipped or late payment under the existing system.

Management’s Response:The Commissioner, SB/SE Division, disagreed with this
recommendation, stating that, although there may be some benefit to
establishing regular quarterly time periods for individual estimated tax payments,
monthly estimated tax payments would increase burden and complexity for both
compliant and noncompliant taxpayers.The Commissioner added that increasing the number of payments would
increase both the complexity of Underpayment of Estimated Tax by Individuals,
Estates, and Trusts (Form 2210) and the difficulty of computing estimated tax
penalties for noncompliant taxpayers.

Office of Audit Comment:Given the significant increase in nonwage income and the
extensive noncompliance with making estimated tax payments, we continue to
believe taxpayers could benefit from a system of regularly scheduled monthly
payment dates.The fact that nearly one-third
of the taxpayers that make estimated tax payments incur penalties strongly
suggests the current quarterly payment system, in place since 1943, is not
working effectively.Monthly payment
intervals are an established and common business practice in the private
sector.Most Americans are already used
to making monthly payments on their home mortgages, rent, car loans, credit
cards, and utilities.Many utility
companies establish fixed monthly billing dates whereby their customers pay the
same amount on the same date of each month through an even billing process.In addition, many homeowners have mortgage
escrow accounts set up to have money held to pay property taxes and insurance
premiums so they do not have to worry about coming up with several large lump
sum payments, each with different due dates, throughout the year.Also, taxpayers that cannot pay the full
amount with their individual income tax returns can make arrangements with the
IRS to make monthly installment payments.

We believe the Commissioner’s concern with the taxpayer
burden associated with a monthly payment system would be alleviated with the
successful promotion of electronic payments.In addition, the IRS instructions for Form 2210 state that taxpayers do
not need to file the Form in most cases if an estimated tax penalty is due and
that, because the Form is complicated, the IRS strongly encourages the taxpayer
to let the IRS figure the penalty.Finally, substantial taxpayer burden would be reduced if the monthly
payment system helped taxpayers avoid estimated tax penalties.Under a monthly system, 12 smaller payments
would be spread out over a year.Therefore, the estimated tax penalty for one skipped or late monthly
payment would be less than that for a skipped or late quarterly payment under
the existing system, which requires larger payment amounts and longer intervals
between payments.

3.Develop a legislative proposal, for submission to the
Department of the Treasury, to change the manner in which the estimated tax
penalty rate is determined to ensure it serves as a more effective deterrent to
noncompliance with estimated tax payment requirements.

Management’s Response:The Commissioner, SB/SE Division, disagreed with this
recommendation, stating that, in July 2001, the IRS had developed a legislative
proposal recommending the Congress raise the minimum underpayment amount on which
penalties are assessed for failure to make estimated tax payments and change
the rate at which the estimated penalty is determined.The proposed changes would apply to tax
years beginning after December 31, 2003.The Commissioner stated the proposal has been incorporated into Section
201 of Senate Bill (S.) 882, Tax Administration Good Government Act, and,
therefore, the IRS does not believe developing an additional legislative
proposal is required.

Office of Audit Comment:We continue to believe our recommendation has merit.The legislative proposal cited by the
Commissioner, SB/SE Division, was referred to the Senate Committee on Finance
on April 10, 2003, and had not been acted on as of January 15, 2004.While applying the underpayment rate on a
daily basis would increase the amount of the estimated tax penalty, the
increase would not, in our opinion, be sufficient to effectively deter
taxpayers from avoiding estimated tax payments.By our calculations, for example, a taxpayer who missed making a
$5,000 estimated tax payment for the October - December 2003 quarter would face
an increased penalty of only 66 cents under the proposed tax law change.

To assist in promoting the IRS’ goals to provide prefiling
taxpayer assistance, potentially reduce the significant number of taxpayers
that are incurring estimated tax penalties and/or filing balance due returns,
and potentially reduce the IRS’ eventual collection costs, the Directors,
Compliance, SB/SE and W&I Divisions, and the Director, Customer Assistance,
Relationships, and Education, W&I Division, should coordinate to:

4.Develop and send educational midyear reminder notices to those
taxpayers that were assessed estimated tax penalties in the prior tax year and
had made no estimated tax payments during the first 6 months of the current tax
year or had made substantially smaller payments or untimely payments during the
first 6 months.This notice would
remind taxpayers of the estimated tax requirements and potentially help them
avoid significant penalties before they fall too far behind in their estimated
tax payment obligations.

Management’s Response:The Commissioner, SB/SE Division, disagreed with this
recommendation, stating that, in early 2000, the IRS had initiated a “soft
letter” project to determine whether a “soft letter” would significantly
increase FTD payment compliance.The
Commissioner advised that, based on the results of that study, a reminder
notice would have little or no impact on payment compliance.

The Commissioner also disagreed with our estimate that
penalty and interest could be reduced by $2.1 billion over 5 years by assuming
the midyear reminder notice could result in a 25 percent increase in payment
compliance, stating that the percentage was not based on any empirical
data.The Commissioner also did not
agree that sending reminder notices to taxpayers assessed estimated tax
penalties would reduce collection costs by $12.9 million over 5 years, stating
that, based on the results of the FTD “soft letter” study, there would be no
collection cost savings and that our estimate did not reflect the
administrative cost of adding a midyear reminder notice.

Office of Audit Comment:We believe the concept of a midyear reminder notice to taxpayers
that have stopped making estimated tax payments should, at a minimum, be
tested.The Commissioner, SB/SE
Division, cited the results of an FTD “soft letter” project as evidence that a
reminder notice would have little or no impact on estimated tax payment
compliance.However, the IRS’ own final
report, dated March 2003, on the results of that project recommended “further
study about the effectiveness of the ‘soft letter’ as an early intervention
tool to improve filing and payment compliance may be warranted.”Further, the report on the FTD “soft letter”
project stated sending a “soft letter” to the taxpayer helped to “winnow out”
earlier in the collection pipeline some cases that did not need further
contact.Finally, the FTD “soft letter”
was directed to businesses responsible for paying employment taxes.This customer segment significantly differs
from individual taxpayers that are responsible for making estimated tax
payments on their nonwage income.

While the Commissioner, SB/SE Division, is correct that
there are no empirical data to support our assumption that a midyear reminder
notice would improve payment compliance by 25 percent, our estimate that
penalties and interest could be reduced by $412.7 million per year, or $2.1
billion over 5 years, was based on 285,400 taxpayers becoming payment
compliant.These 285,400 taxpayers
represented only about 5 percent of the 5.7 million noncompliant taxpayers that
incurred estimated tax penalties in TY 1998.Similarly, our estimate of the cost savings that could be realized
through a 25 percent improvement in payment compliance was based on avoiding
collection action on approximately 204,000 taxpayers.Our estimate of the collection cost savings was reduced by the
estimated cost to mail the reminder notices.Our methodology in arriving at these estimates is presented in detail in
Appendix IV.

5.Consider including Tax Form 9783 in the estimated tax packages
mailed to taxpayers, expanding the brief explanation of the EFTPS in
Publication 505, and amending those IRS instructions and publications
applicable to estimated tax payments that do not sufficiently emphasize the
EFTPS is offered to taxpayers as a free service by the Department of the
Treasury.

Management’s Response:The Commissioner, SB/SE Division, agreed with this
recommendation, stating an E-Submissions Messaging Team was created in August
2003 to ensure information concerning IRS payment options is available and
consistent in IRS tax products.The
group is currently reviewing small business publications, notices, and IRS tax
packages to ensure electronic payment options are displayed prominently and
EFTPS benefits and uses are specifically detailed.The proper messages emphasize the EFTPS as the preferred payment
option and highlight it as a “free” service offered by the Department of the
Treasury.

This group will continue to review new ways to enhance Form
1040-ES taxpayer compliance.Proposals
under consideration include 1) adding a coded Form 9783 in the U.S. Individual
Income Tax Return (Form 1040) tax package to track the number of enrollments
submitted through the paper enrollment process, and 2) providing an information
insert describing the benefits and use of the EFTPS and directing taxpayers to
the applicable web site for electronic enrollment.

Our objective was to determine if the Internal Revenue Service
(IRS) has effective processes for achieving timely intervention when an
underpayment or nonpayment of income taxes, Federal Tax Deposits (FTD), and/or
estimated taxes is identified.

To meet this objective, we:

I.Evaluated the use of outbound calls and timely intervention
activities performed by the Automated Collection System (ACS) function.

A.Evaluated the types of cases worked at the ACS call sites and
determined whether management believes the early intervention method may not be
productive.

B.Analyzed the types of cases for which the ACS function makes
outbound calls and determined whether the outbound calls are successful in
collecting funds and closing cases.

C.Obtained and analyzed the entire population of 1,136 cases
from an “ACS Over $25,000 Case Analysis Study” completed by the Wage and
Investment Division to compare the cases closed by the ACS function with
outbound calls and the cases closed without outbound calls.

D.Determined the status of the Small Business/Self-Employed
Division’s Collection Process Improvement study that addresses the use of the
predictive dialer as a method for working more ACS function cases.

E.Evaluated the feasibility of the predictive dialer process to
perform additional outbound calls for the ACS function.

F.Analyzed the status of the Business Systems Modernization
project for Filing and Payment Compliance that includes a model to shorten the
payment compliance life cycle.

II.Evaluated the effectiveness of the FTD Alert Program that is
designed to prevent delinquencies for small business taxpayers.

A.Identified the objectives and goals of the FTD Alert Program
and determined whether there is a system to measure Program results.

B.Evaluated the status of IRS management’s corrective actions
for five audit recommendations on FTD Alerts contained in an audit report
issued by the former IRS Inspection function (Service Procedures for
Monitoring Federal Tax Deposits (Reference Number 085105, dated August 14,
1998)).

C.Evaluated the status of IRS management’s corrective actions
for a recommendation on FTD Alerts contained in an audit report issued by the
Treasury Inspector General for Tax Administration (Consolidated Report on
Opportunities for the Internal Revenue Service to Improve Service to Business
Taxpayers (Reference Number 2000-30-015, dated December 1999)).

D.Evaluated the current FTD Alert process and the status of IRS
Research Projects on the development and testing of a new FTD Alert model.

E.Considered methods to improve the FTD Alert Program, e.g.,
moving the alerts from the Collection Field function to a predictive dialer for
outbound calls.

III.Evaluated the need for a delinquency prevention program for
individual taxpayers required to make estimated tax payments.

A.Identified the objectives and goals of the estimated tax
program.

B.Analyzed an IRS Individual Master File (IMF) extract of all Tax Year 1998 individual income tax accounts for
which the taxpayers had (1) filed a return
after its Calendar Year (CY) 1999 due date or (2) filed a timely return in CY
1999 but had not paid all taxes due by the regular April 15 return due
date.The extract identified
2,025,189 taxpayers that were assessed the estimated tax penalty.

C.Considered methods to improve the estimated tax process, such
as sending reminder notices to previous estimated tax filers if they do not
make any estimated tax payments in the first two payment periods and/or making
outbound calls to these taxpayers.

IV.Evaluated early intervention programs employed by state tax
agencies.

A.Sent questionnaires to nine state governments to inquire about
their collection techniques and early intervention practices.

B.Evaluated the six questionnaire responses received and
determined whether there are best practices that would benefit the IRS
operations.

This appendix presents detailed information on the
measurable impact that our recommended corrective actions will have on tax
administration.These benefits will be
incorporated into our Semiannual Report to the Congress.

Inefficient
Use of Resources – Potential; $2.6 million; over 5 years, $12.9 million in
reduced collection costs for the Internal Revenue Service (IRS) by
improving payment compliance through the development of a midyear reminder
notice for estimated tax payments (see page 9).

Methodology Used to Measure the Reported Benefit:

We analyzed an IRS Individual Master File (IMF) extract that
included all Tax Year (TY) 1998 individual
income tax accounts for which the taxpayers had (1) filed a return after its Calendar Year (CY) 1999 due date or (2)
filed a timely return in CY 1999 but had not paid all taxes due by the regular
April 15 return due date.This
extract identified 2,025,189 taxpayers that were assessed the estimated tax
penalty.The following methodologies
were used to estimate the reported benefits:

Taxpayer Rights and Entitlements:We analyzed all 2,025,189 taxpayer
accounts extracted from the universe of 5.7 million taxpayers assessed
estimated tax penalties.Our analysis showed 1,141,599 of the 2,025,189 taxpayers could have benefited from midyear
reminder notices from the IRS as a potential means for improving payment
compliance and reducing collection costs.We assumed a 25 percent improvement in payment compliance from the
reminder notice and determined these taxpayers could avoid $412.7 million in
penalties and interest.

As shown in Table 1, these 1,141,599 taxpayers were assessed nearly $1.7 billion in
penalties and interest for TY 1998:

Assuming that sending midyear estimated tax payment reminder
notices potentially would result in a 25 percent improvement in taxpayer
payment compliance, the reduced penalty and interest would be $412,710,250
($1,650,840,998 X .25) per year, or nearly $2.1 billion over 5 years for
285,400 taxpayers (1,141,599 X .25).The estimated outcomes are based on achieving payment compliance by only
5 percent (285,400/5.7 million) of the taxpayers assessed estimated tax
penalties.

Inefficient Use of Resources:We
analyzed 2,025,189 taxpayer accounts from the universe of 5.7 million taxpayers
assessed estimated tax penalties.Our analysis indicated 1,141,599 of the
2,025,189 taxpayers could have benefited from midyear reminder notices from the
IRS as a potential means to prevent or minimize future estimated tax penalties,
future balance due returns, and future accounts receivable.These included:

·603,533 taxpayers that were assessed estimated tax penalties for TY 1997 but made
no estimated tax payments for TY 1998.

·111,913 taxpayers that made estimated tax payments for
TY 1997 but made none for TY 1998.

154,731
taxpayers that made substantially
smaller estimated tax payments for TY 1998 than for TY 1997.

Our analysis showed 324,928 of the
1,141,599 taxpayers fully paid their taxes when they filed their returns, and
the IRS subsequently sent 1 or more collection notices for delinquent taxes
and/or penalties and interest to the remaining 816,671 taxpayers.In addition, the accounts of 143,497
taxpayers eventually reached the Taxpayer Delinquent Account (TDA) status in
the Automated Collection System (ACS) function inventory, and 26,580 of these
were ultimately referred to the Collection Field function (CFf) for resolution.